Mortgage points

If you plan to obtain a mortgage loan in the United States, it is a good idea to learn a bit about origination points and discount points.

Origination points

Origination fee is a fee paid by the borrower to the lender when the borrower is approved for a loan. (It is different from an application fee, since an application fee can be charged even for a loan application that is turned down.)

In the United States, many lenders won’t say that the origination fee is 2% of the borrowed amount. Instead, they will say that you must pay 2 origination points. If you have to pay 3 origination points, that’s a 3% origination fee, and so on.

Under U.S. tax law, the origination fee is tax deductible for the borrower as long as the origination fee is only used to obtain the mortgage loan and not to pay for closing costs. (Examples of closing costs: preparation costs, inspection costs, notary costs.)

Discount points

In the United States, you can pay discount points when you obtain the loan (at closing). Paying discount points will decrease the stated interest rate on the mortgage loan. Of course, you are giving money to the borrower so it’s not like you’re actually getting a discount. It’s more like paying some of the interest in advance.

Example:

You want to buy a house for $180,000. You have a $15,000 down payment and needs to borrow $165,000. The bank is offering you a $165,000 mortgage loan that will run for 30 years and have a fixed 6% interest rate. You would pay $989 per month.

However, the bank is also presenting your with an alternative. You can get the same loan, but with a 5.5 interest rate, if you pay them 2 discount points when the loan is approved. 2 discount points = 2% of the borrowed amount. $165,000 x 0.02 = $3,300.

If you chose the alternative solution, you would pay $937 per month. Are you willing to pay $3,300 today to get the monthly payment down with $52 for the 30 year term?

$52 x 12 months x 30 years = $18 720.

Of course, $1 today can be worth significantly more than $1 in the future. Not just because of factors such as inflation, but also because of our personal circumstances. A person buying a house might be struggling to get together a down-payment, money for closing costs, might still be paying rent on the old place, and so on. In such as situation, spending several thousand dollars on discount points might not be a good idea, especially not if the money would come from a high-interest short-term credit such as a credit card.

In general, homeowners that plan to stay in the house for the duration of the mortgage tend to be more eager to pay discount points. People who only see themselves living in this house for a few years or so are less interested in paying a lump sum upon closing to get the interest rate down, since they plan to pay off the entire mortgage loan when they sell the house in a few years.

Most mortgage loan lenders in the United States will let you chose between paying anywhere from zero to four discount points upon closing. The discount points are tax-deductible, since they are a form of interest on a loan.